Slides prepared by Dr. Amy Peng, Ryerson University Part Two: Microeconomics of Product Markets...
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Slides prepared by Dr. Amy Peng, Ryerson University Part Two: Microeconomics Part Two: Microeconomics of Product Markets of Product Markets CHAPTER 5 CHAPTER 5 CONSUMER CHOICE CONSUMER CHOICE AND UTILITY AND UTILITY MAXIMIZATION MAXIMIZATION
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Transcript of Slides prepared by Dr. Amy Peng, Ryerson University Part Two: Microeconomics of Product Markets...
Slides prepared by Dr. Amy Peng, Ryerson University
Part Two: MicroeconomicsPart Two: Microeconomicsof Product Marketsof Product Markets
CHAPTER 5 CHAPTER 5 CONSUMER CONSUMER CHOICE AND CHOICE AND
UTILITY UTILITY MAXIMIZATIONMAXIMIZATION
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5 2
In this chapter you will learn: In this chapter you will learn:
5.1 About total utility, marginal utility, and the law of diminishing marginal utility
5.2 How rational consumers compare marginal utility-to-price ratios for products in purchasing combinations of products that maximize their utility
5.3 How a demand curve can be derived by observing the outcomes of price changes in the utility-maximization model
5.4 How the utility-maximization model helps highlight the income and substitution effects of a price change
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.1 3
Law of Diminishing Marginal Law of Diminishing Marginal UtilityUtility
• Gains in satisfaction decline as additional units are consumed
• Terminology– utility is want-satisfying power
• Total Utility and Marginal Utility– total utility: total amount of
satisfaction– marginal utility: extra satisfaction
from consuming one more unit
graphically examined....graphically examined....
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.1 4
TacosConsumed
TotalUtility
MarginalUtility
01234567
010182428303028
Total Utility
0
10
20
30
40
0 1 2 3 4 5 6 7 8
Quantity
To
tal u
tility
Figure 5-1Figure 5-1Total and Marginal UtilityTotal and Marginal Utility
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.1 5
TacosConsumed
TotalUtility
MarginalUtility
01234567
010182428303028
Total Utility
0
10
20
30
40
0 1 2 3 4 5 6 7 8
Quantity
To
tal u
tility
Marginal Utility
-50
510
15
0 1 2 3 4 5 6 7 8
Quantity
Mar
gina
l util
ity
Total and Marginal UtilityTotal and Marginal Utility
10
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.1 6
TacosConsumed
TotalUtility
MarginalUtility
01234567
010182428303028
Total Utility
0
10
20
30
40
0 1 2 3 4 5 6 7 8
Quantity
To
tal u
tility
Marginal Utility
-5
0
5
10
15
0 1 2 3 4 5 6 7 8
Quantity
Mar
gina
l util
itiy
Total and Marginal UtilityTotal and Marginal Utility
10 8 6 4 2 0-2Diminishing
Marginal Utility
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.1 7
• If marginal utility falls rapidly for each successive unit…
• It will take a considerable drop in price to cause an increase in quantity demanded…
• So demand is fairly…• INELASTIC
Marginal Utility and DemandMarginal Utility and Demand
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 8
Theory of Consumer ChoiceTheory of Consumer Choice
A Typical Consumer…• Exhibits rational behaviour• Knows clear-cut preferences• Is subject to a budget constraint• Responds to price changes
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 9
Utility-Maximizing RuleUtility-Maximizing Rule
• The consumer’s money income should be allocated so that the last dollar spent on each product purchased yields the same amount of extra (marginal) utility
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 10
Numerical ExampleNumerical Example
• First, put the marginal utilities into a per-dollar-spent basis
• Decision-making process: at each step, spend where the marginal utility per dollar is highest
• Table 5-1
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 11
Product A p=$1
Product B p=$2
Unit of product
Marginal utility MU/p MU MU/p
1st 10 24
2nd 8 20
3rd 7 18
4th 6 16
5th 5 12
6th 4 6
7th 3 4
1010
88
77
66
5544
33
1212
1010
99
8866
3322
Table 5-1
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 12
MU/p, Product
A
MU/p, Product
B
1st 10 1st 12
2nd 8 2nd 10
3rd 7 3rd 9
4th 6 4th 8
5th 5 5th 6
6th 4 6th 3
7th 3 7th 2
Spending
Product A
Product B
$2$2 11
$3$3 1111
$2$2 11
$3$3 1111
$10$10 4422
What will the What will the consumer buy first?consumer buy first?
What will the What will the consumer buy first?consumer buy first?
And next?And next?And next?And next?
Table 5-2Sequence of Purchases to Achieve Consumer
Equilibrium
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 13
Utility MaximizationUtility Maximization
• At each step, spend where MU/$ is highest
• In general, if MU/$ is unequal, spending should be allocated – away from the good where MU/$ is
low– toward the good where MU/$ is high
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.2 14
MU of product A
Price of A
MU of product B
Price of B=
Algebraic RestatementAlgebraic Restatement
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 15
Utility Maximization and the Demand Utility Maximization and the Demand CurveCurve
Deriving the Demand Curve• What if the price of Product B
falls to $1?
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 16
Product A p=$1
Product B p= $1
Unit of product
Marginal utility MU/p MU MU/p
1st 10 24
2nd 8 20
3rd 7 18
4th 6 16
5th 5 12
6th 4 6
7th 3 4
1010
88
77
66
5544
33
2424
2020
1818
16161212
66
44
Table 5-1Table 5-1
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 17
MU/p, Product
A
MU/p, Product
B
1st 10 1st 24
2nd 8 2nd 20
3rd 7 3rd 18
4th 6 4th 16
5th 5 5th 12
6th 4 6th 6
7th 3 7th 4
Spending Product AProduct
B
◄$1$1 11
◄$1$1 11
◄
$1$1 11
◄
$1$1 11$1$1 11
◄ ◄
◄
$1$1 11$1$1 11$1$1 11
◄
$10$10 6644$1$1 1111
◄
◄
Decision Making ProcessDecision Making Process
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 18
• When pProduct B = $2– the quantity demanded is 4
• When pProduct B = $1– the quantity demanded is 6
Utility Maximization and the Demand Utility Maximization and the Demand CurveCurve
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 19
Product B
Price Quantity demanded
$1
$2
6
4
4
$1
$2
D
6
price
quantity demanded
Figure 5-2Figure 5-2Deriving an Individual Demand CurveDeriving an Individual Demand Curve
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.3 20
• Substitution Effect– when the price of Product B falls,
there is a substitution of now cheaper B
• Income Effect– increase in real income increases
consumption of both A & B
Utility Maximization and the Demand Utility Maximization and the Demand CurveCurve
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5.4 21
Applications and ExtensionsApplications and Extensions
• DVDs and DVD Players• The Diamond-Water Paradox• The Value of Time• Cash and Non-Cash Gifts
©2007 McGraw-Hill Ryerson Ltd.
Chapter 5 22
Chapter SummaryChapter Summary
5.1 The Law of Diminishing Marginal Utility
5.2 Theory of Consumer Choice– Marginal Utility per Dollar
5.3 Utility Maximization and the Demand Curve
– Income and Substitution Effects 5.4 Applications and Extensions
